RicAguiar/E+ via Getty Images
RicAguiar/E+ via Getty Images
Last year, I wrote about how Advanced Drainage Systems (NYSE:WMS ) has a good multi-year growth outlook, but was overvalued and needed a pullback. The pullback in WMS did happen since then along with the market's decline. I see strong potential upside for the stock now that the pullback has taken place.
Advanced Drainage Systems produces HDPE (high-density polyethylene), polypropylene, and PVC pipes for water drainage management. The company also supplies drainage grates, water storage chambers, construction fabrics, septic tanks/accessories, and related products. WMS's products have an advantage of being less costly than alternatives such as steel or concrete pipes. Projects can also be completed in less time with HDPE. ADS is a leader in corrugated plastic drainage pipe with over 10 billion feet of pipe in service throughout the world.
ADS has strong tailwinds as the global stormwater treatment system market is expected to grow at a compound annual growth rate of 8.5% to 2028. This growth would take the market from about $13 billion in 2021 to about $23.5 billion in 2028. We have witnessed many extreme storms leading to flooding in recent years throughout the world. So, the need for ADS's solutions are likely to be in strong demand for many years.
ADS's solutions cover the following phases of water drainage management: capture, conveyance, storage, and treatment. This provides a complete package for customers covering all aspects of storm water management. The company is a key water solutions provider on a global basis. WMS provides solutions for large non-residential projects and also smaller residential projects.
ADS beat estimates for revenue and earnings for fiscal Q3 2022. Revenue increased 47% year-over-year in Q3 to $715 million. This marked record revenue for ADS. The revenue for Q3 also beat estimates by about 10% or $64 million. The revenue growth was driven by price and volume for storm water management systems (ADS business) and on-site septic systems (Infiltrator business).
Normalized EPS increased 57% to $1.27 in Q3, beating estimates by 26%. Consolidated adjusted EBITDA increased 27%. ADS's strong profitability returns such as the ROE of 26% and ROIC of 12% help drive its earnings growth. This is higher than the sector median ROE of 14% and ROIC of 7%.
ADS is scheduled to report earnings on May 19 for fiscal Q4 2022. The quarterly estimate EPS is $0.64 for Q4 and $3.48 for the year. If the yearly estimate is achieved, it would result in an earnings increase of 34% over last fiscal year. FY23 also looks bright with analysts expecting earnings growth of 37% to 38%.
ADS is seeing a favorable backlog and pace of orders. The company is projecting demand to be strong for the foreseeable future. Given the positive momentum that the company has been achieving, Q4 has a good chance of being positive. We'll have to see what ADS says in the Q4 report, but I doubt that anything changed much regarding the outlook for next fiscal year.
Another plus is that ADS could benefit from the infrastructure bill. The U.S. infrastructure bill allocates $330 million per year for improvements in stormwater management. As a leader in stormwater management, ADS could get ongoing orders to address some of these concerns as part of the bill.
When I previously wrote about ADS in July 2021, the stock was trading with a forward PE of about 32. The recent market selloff brought the forward PE down to about 21 based on the expected EPS of $4.79 for FY23. Granted, this isn't a bargain valuation, but it is a significant improvement as compared to last year.
There might be some hidden valuation for ADS. Multiple sources including Seeking Alpha are not reporting a forward PEG ratio for ADS. This typically takes the forward PE divided by the estimated earnings for the next 3 to 5 years. We know that the forward PE looking one-year ahead is 21. We also know that the estimated earnings growth is projected to be 37% to 38% for FY23 over FY22. So, the one-year forward PEG ratio is 21/37 = 0.56. PEG ratios below one are considered a bargain valuation for growth stocks. So, I feel that WMS is now trading at a level that is attractive for a long-term position.
The daily stock chart above shows bullish divergence between the RSI and the stock price. The stock price was in oversold territory in January on the RSI. However, the stock declined lower over the next few months while the RSI remained just above the oversold level. The RSI and stock price recently increased from the near oversold condition. The higher low in the RSI from January to May and the lower low in the price during the same period is bullish divergence.
The green MACD line appears to be close to crossing above the red signal line, indicating a possible change to a positive trend. The money flow [CMF] has been rising from a negative level and hit the zero line. These indicators are pointing to a potential positive change in trend for the stock. Of course, this depends on how the broader market behaves in the near term.
The improvement in valuation leaves room for plenty of upside for WMS. The company is likely to get steady orders from both the residential and non-residential markets to address stormwater management. There has been an increase in the frequency and duration of floods in recent years. This creates an ongoing need to improve store water management. ADS stands to benefit as the company provides solutions for all phases of storm water management.
Investors should read the May 19 earnings report to see if there are any changes in the company's performance and outlook. My guess is that the company's outlook will remain positive given the need for its solutions.
Analysts have a one-year price target of $150 for the stock, which would be 48% higher than the current price. This would take the PE up to 31 based on expected EPS of $4.79 for FY23, which was where the stock was trading last year. ADS is one of those companies that will probably maintain an above-average valuation PE-wise due to its multi-year positive growth outlook. This is why the PEG ratio will probably remain attractive as ADS increases earnings at a strong pace.
Consider joining Kirk Spano's Margin of Safety Investing which offers a more in-depth analysis of individual companies.
Try Margin of Safety Investing free for two weeks and get your first year for 20% off.
Learn the 4-step investment process that top hedge funds use.
Invest with us in a changing world that demands a margin of safety.
This article was written by
Through diligent analysis, he is ranked in the top 1% of blogging analysts on Tipranks.com for performance and accuracy. David previously contributed to Kirk Spano's Margin of Safety Investing [MoSI] Marketplace Service and Risk Research Inc.
David focuses on growth & momentum stocks that are reasonably priced and likely to outperform the market over the long-term. He is a long term investor of quality stocks and uses options for strategy.
David told investors to buy in March 2009 at the bottom of the financial crisis. The S&P 500 increased 367% and the Nasdaq increased 685% from 2009 through 2019.
He wants to help make people money by investing in high-quality growth stocks.
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The article is for informational purposes only (not a solicitation or recommendation to buy or sell stocks). David is not a registered investment adviser. Investors should do their own research or consult a financial adviser to determine what investments are appropriate for their individual situation. This article expresses my opinions and I cannot guarantee that the information/results will be accurate. Investing in stocks involves risk and could result in losses.